The fiscal costs of systemic banking crises

• Author: David Amaglobeli,Mariusz Jarmuzek,Nicolas End,Geremia Palomba
• Published date: 01 March 2017
• Date: 01 March 2017
• DOI: http://doi.org/10.1111/infi.12100

DOI 10.1111/infi.12100

ARTICLE

The fiscal costs of systemic banking crises

David Amaglobeli

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Nicolas End

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Mariusz Jarmuzek

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Geremia Palomba

International Monetary Fund,

Washington, DC, USA

Correspondence

Nicolas End, International Monetary

Fund, 700 19th St NW, Washington, DC

20431, USA.

Email: nend@imf.org

Abstract

This paper examines fiscal costs of systemic banking

crises. It uses a dataset of 65 crisis episodes since 1980

and considers both the direct budgetary cost of

government intervention and the overall fiscal impact

as proxied by changes in the public debt-to-GDP ratio.

We find that both direct and overall fiscal impacts of

banking crises are high when countries enter the crisis

with large banking sectors, rely on excessive external

funding, have highly leveraged non-financial private

sectors, and resort to using government guarantees on

bank liabilities during the crisis. Better quality of

banking supervision and higher coverage of deposit

insurance help, however, alleviate the direct fiscal costs.

We also identify a policy trade-off: costly short-term

interventions are not necessarily associated with larger

increases in public debt, supporting the thesis that

immediate intervention may actually be a more cost-

effective solution over the long term.

The views expressed in this paper are those of the authors and do not necessarily represent the views of the IMF, its

Executive Board, or IMF management.

The International Monetary Fund retains copyright and all other rights in the manuscript of this article as submitted for

publication.

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© 2017 John Wiley & Sons Ltd wileyonlinelibrary.com/journal/infi International Finance. 2017;20:2–25.

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INTRODUCTION

The recent global financial crisis has renewed research and policy interest in the effects of banking

crises on public finances. Since 2007, there have been 25 new systemic and borderline systemic

banking crises, mostly in advanced economies, which have often carried significant fiscal costs. In

Iceland and Ireland, for example, the cost of government intervention amounted to more than 40% of

GDP, and public debt increased by more than 70% of GDP in five years (Lane, 2011). The magnitude of

these costs does not stand out from past crises.

Systemic banking crises have often resulted in marked deteriorations of public finances, although the

impact has varied across countries. The median fiscal cost of direct government intervention during the

crises that occurred between 1980 and 2011 was about 6% of GDP; about one third of crisis episodes

recorded direct fiscal costs exceeding 10% of GDP. Yet, these direct costsdo not capture the full impact of

banking crises; public finances are also indirectly affected through crisis-induced recessions and tighter

financing conditions (Claessens et al., 2011; International Monetary Fund [IMF], 2015). The o verall cost of

crises can be better captured by the change in public debt, which in addition to direct budgetary outlays

includes also the indirect fiscal consequences that materialize through the impact of crises on the real

economy. Seen through this prism, the overall costs of banking crises are even larger. The median increase

in public debt during the four years that followed crises was more than 14% of GDP, with the increase

exceeding 40% of GDP for the 11 costliest crises, and about 24% for the recent wave of crises. However, it is

important to note that the change in public debt levels is not fully attributable to banking crises.

Explaining the magnitude of and the cross-country differences in fiscal costs of banking crises

remains a challenge. This paper provides an empirical analysis of the factors associated with direct

fiscal costs of banking crises and public debt dynamics. It combines several recent datasets to examine

the role of pre-crisis banking sector characteristics, regulatory and supervisory frameworks, and policy

responses in explaining the fiscal costs of crises. Our analysis covers 65 systemic and borderline

systemic banking-crisis episodes, including the global financial crisis.

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This paper addresses some limitations of the existing literature on banking crises. First, empirical

studies have largely focused on direct fiscal costs and suggest that the determinants of banking crises

may also help explain observed differences in the severity of the fiscal impact of banking crises

(Demirgüç-Kunt & Detragiache, 1998). However, this literature dates back to the late 1990s and early

2000s; as such, it does not account for the complexities of modern banking sectors, such as cross-border

linkages. Second, the existing literature mainly considers the determinants of fiscal costs separately,

not accounting for possible interactions between risk factors. Third, beyond direct bailout costs, the

literature has not paid much attention to the overall impact of banking crises on the sovereign. Yet, this

is an important policy issue: public interventions, although initially costly, may lead to better

macroeconomic performance and smaller increases in public debt (IMF, 2015). Thus, this paper

departs from previous literature and examines both the direct fiscal costs of banking crises and their

overall costs as summarized by debt dynamics. Admittedly, the change in public debt is an imperfect

measure of the overall impact of banking crises on public finances, but it is also more comprehensive.

Analysing both direct and overall costs has another advantage. It allows the exploration of possible

empirical trade-offs between the size of initial fiscal outlays and subsequent impacts on fiscal accounts.

The paper shows that there is no single model or set of factors that explains fiscal costs of banking

crises. We find, however, some aggravating factors. First, fiscal costs of banking crises depend on the

pre-crisis structure and institutions of the financial sector. Costs are higher in countries where the

banking sector is larger, more leveraged or more reliant on external funding. On the other hand, costs

tend to be lower where banking supervision is stronger and deposit insurance coverage broader. Thus,

recent trends towards more leveraged and internationally integrated banking sectors may pose

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